Stop Signing Away Your Subcontractor Profits

By Duane Craig

May 29, 2017

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Few people enjoy reading contracts. Their never-ending sentences cause your eyes to glaze over and your mind to go numb. Performance bond and insurance language are equally boring. But, by not taking the time to carefully review and understand these documents, subcontractors are taking on more risk than they can handle. And in the process, they’re giving away profits to pay legal fees.

The Pitfalls of Indemnification

Indemnification, or hold harmless clauses, are a standard way of apportioning risk, so the parties that cause damages are the ones who pay. Owners continue to push more risk down the chain, but it’s not done equitably because of language appearing within these indemnification clauses, according to Timothy J. Woolford of Woolford Law, P.C.

Watch out for these phrases:

Arising out of the work - you could be liable for more than your fair share

Injury or damage caused solely by the indemnity’s negligence - you will pay for things that aren’t your fault

Contractor agrees to defend, indemnify and hold harmless - you will pay regardless of how much you are at fault

Subcontractors will incorrectly assume that when their contract doesn’t contain an indemnification clause, they don’t have any obligations. Watch for “flow down” and “incorporation by reference” clauses, and language assigning to you “all obligations and responsibilities” of others. Woolford recommends negotiating changes to these troublesome clauses to bring them in line with standard American Institute of Architects contract language. You should also be wary of relying on your commercial general liability policy to cover you when one of these contract clauses is triggered.

Contractual Liability Sinkholes

General liability policies include contractual liability insurance. This insurance covers you for liabilities arising from the actions of others, and it comes into play when there are indemnity or hold harmless claims. But, because legislators are currently hostile to indemnity clauses, and certain endorsements to insurance policies remove coverage for indemnity clauses, owners are using the ‘additional insured’ clause so they are added to the general liability policy of the general contractor, and the policies of all subcontractors.

Insurers writing policies for subcontractors take heavy hits when defending cases involving ‘additional insureds,’ according to John H. Podesta, attorney specializing in insurance coverage. In these cases, they also have little control over how the owners and general contractors are defended. That has caused underwriters to work harder at lowering their risks in these claims with proprietary endorsements (endorsements not written by the Insurance Services Office). Exclusions added to endorsements can make you out of compliance with insurance requirements.

You need to know how you can satisfy the insurance requirements of a project contract long before you take the time to bid on it. In some case, you might not be able to get the required insurance. Before bidding on a project, review the contract documents in the bid package with your legal counsel to make sure there are no issues with hold harmless and additional insured.

Troublesome Bond Issues

There are some clauses placed in your subcontract with the general contractor that can raise red flags for a surety company considering issuing your bond. These widely used clauses intend to pass risk to you, and while standard in many contracts, that doesn’t mean they are mandatory. Depending on all other factors, you could successfully negotiate changes or deletions of these.

“Flow down” and “pass thru” clauses can obligate you to the same conditions as negotiated between the general contractor and the owner. These conditions could include personal indemnity which requires you to place personal assets at risk.

The “no notice required” clause can allow the general contractor to remove and replace you without giving notice. This removes protections that surety issuers want, while also shutting down your ability to remedy the problem.

The “pay if paid” clause makes it difficult for a subcontractor to get paid when the owner hasn’t first paid the general contractor. Bonding companies view this negatively because of the uncertainty it places in the payment process. When the “indemnity clauses” are broad form and covering the owner against its own mistakes, subcontractors might be responsible for covering those expenses.

There are also job conditions that can trigger an unfavorable surety response in a request for a bond. One example is when a sub has a role that comes in the late stages of a project. When that happens, the bond has a long carrying time without any performance on the contract. The bond issuer might feel more exposed to changes in the subcontractor’s business.

Bonds are Not Insurance

Many people incorrectly assume that subcontractor default insurance provides the same protections as bonds.

“Bonds and insurance have one fundamental difference between them,” Christopher G. Hill, construction lawyer, wrote in his blog. “When your construction company buys insurance, that insurance is meant to protect your company. When your company provides a payment and/or performance bond, that bond is there not to protect your company, but to protect everyone else on the job and the project itself.”

If the general contractor is asking you to provide bond, but the general contractor is not providing bond, you might have problems with two contract clauses. If “pay if paid” or “flow down” clauses are in the contract, then you are improving the general contractor’s and owner’s positions, while not improving your own position. And, you’re paying to do it.

A final note on bonds has to do with bonding capacity. Your bonding capacity is limited based on company history, finances, and other factors. If you take on a project requiring a bond, and that bond amount is almost as high as your capacity, then you can’t take on any new work requiring a bond because you don’t have enough capacity remaining. Plan your project portfolio with your bond capacity in mind.